A+BxC=Audit

Most everyone knows that there are certain common parameters that make you more likely to get audited by the IRS, such as:

  • making more than $100,000
  • having low income and high expenses
  • carrying inventory
  • claiming high deductions for meals and entertainment, travel, and car expenses
  • being self-employed and/or claiming a home office
  • holding a mostly cash-income job, such as waiting tables or bartending

But did you know that the IRS actually uses a very strict formula to determine most of the tax returns that get scrutinized? It’s called the “DIF Score,” (Discriminate Income Function) and while the actual formula is very closely guarded secret, it generally works by comparing your income and deductions to other people in your tax bracket. If you donate an unusual amount to charity, or claim an unusual amount of driving mileage compared to others who make about the same as you, your DIF score goes up. The highest scoring returns then get scrutinized by an IRS agent, who determines whether your return warrants an audit. There are other factors that go into your DIF score as well, such as your age and where you live. If you’re 45, live in Beverly Hills, and claim a $25,000 income, for example, your score goes up simply for having unrealistic numbers.

So how can you stay under the radar? There are several strategies, but here are some of the most common:

  • File a neat, professional-looking return. Messy, handwritten returns require closer scrutiny to begin with, and are more likely to include things like mathematical errors.
  • File at the last possible minute. Prepare your return early and have it checked, but don’t turn it in until as close to April 15th as possible. You may even be able to file as late as the October 15th extension date (though you will still need to pay by April 15th). The later you file, the more likely it is that the IRS will have already reached their audit quota.
  • Check and re-check your return. Mathematical errors, wrong social security numbers, lack of signatures, disagreements between your state and federal returns, and numbers that don’t match your W-2 or 1099 forms (of which the IRS gets their own copies) will all red-flag you.
  • Preempt unusual deductions (e.g. your car got totaled or your office burned down) by including a note and receipt about the incident with your return.
  • Watch your medical expenses. You can only claim non-reimbursable expenses (whether you were actually reimbursed for them or not) in excess of 7.5% of your adjusted gross income. This is a complicated deduction, and one that people very often claim incorrectly, so the IRS really likes to pounce on this one.
  • Don’t round numbers up or down.
  • Avoid the use of “miscellaneous” or “other” categories as much as possible.

In the end, even if you manage to blend in with the masses, your return may still be flagged for a random audit. It is therefore best to keep neat receipts and records for everything you claim (see future posts for how to keep proper expense diaries). The more organized you are, the quicker and less painful an audit will be.

Sources: http://money.cnn.com/2004/02/27/pf/taxes/avoidanaudit/index.htm
 http://www.totaltaxsolutions.com/avoid-audit.htm
http://www.askmen.com/money/investing/40_investing.html
http://articles.moneycentral.msn.com/Taxes/AvoidAnAudit/5waysToAvoidAnAudit.aspx

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